China’s Wasted Capital

China has been criticized for being both a miser and wantonly in global trade circles. Its critics bash it both for careless over-investing at home and for depressing world demand through excessive thrift. In fact, it is not the size of Chinese domestic capital investments that stands out, but rather the misguided content of the investments. Considering the size of its economy, China actually needs to create much more capital than it currently possesses in order to reach levels comparable to those of the U.S. or Japan (see Graph 1).

China’s capital stock amounted to about 2.5 times China’s GDP in 2008, according to the APO, which was the same as America’s figure and much lower than Japan’s

Forty-four percent of China’s economic growth is due to brute accumulation of capital. The fact that much of this capital is useless contributes to the fact that Chinese growth model does not increase the living standard of Chinese citizens as well as it could. For one thing, Chinese citizens’ money in bank deposits is deprived of growth because of government-capped interest rates. In terms of trade, the renminbi’s low exchange rate suppresses consumption (by making imports expensive) and supports production of exports. Sadly, the proceeds that the government extracts from its citizens by capping the interest rate and stifling consumption gets malinvested “in speculative assets or excess capacity.”

The ones responsible for the malinvestment of Chinese citizens’ capital are local governments and SOEs (State-Owned Enterprises). It is their doing that 30 per cent of China’s GDP has become driven by demand from the property and construction centres. The officials have made revenues by buying cheap land from farmers who cannot sell directly to developers and who have to accept what the government is willing to pay. They have built cities, expecting urbanization to push people into them, before creating job opportunities for them. The city of Kanbashi, which was designed for 300,000 people, is today occupied by less than 30,000. Its Genghis Khan Square, comparable in size to Beijing’s Tiananmen Square, is utterly desolate.

The urban center of Kangbashi (Ordos, Inner Mongolia) is swept by a single woman every day

Models of housing at the Noble City development sits on display in the new Kangbashi section of Ordos

In a paper called “Das (Wasted) Kapital”, David Dollar and Shang-Jin Wei “reckon that two-thirds of the capital employed by the SOEs should have been invested by private firms instead” mainly because so much of the capital used by SOEs has been left to rot outside. The SOE justify their investments by their incredibly high “profitability”. But the investments are only profitable because of the lack of competition in the markets that the SOEs occupy. What’s more, the SOEs’ input of land, energy and credit are artificially cheap. It is not surprising then that Unirule, a Beijing think-tank, has shown that “the SOEs’ profits from 2001 to 2008 would have turned into big losses had they paid the market rate for their loans and land.”


Old houses are demolished to make space for construction projects of local governments and SOEs

Miles and miles of empty houses in Huaxi village

China needs to change its growth model as quickly as possible because its economic growth itself is growing. Thus, as China acquires more know-how, better technology and development techniques, it produces more and more capital, which the government squanders. A good solution was proposed by Premier Li Keqiang, who urged “the introduction of a property tax, the reduction of local governments’ over-reliance on land auctions, the construction of housing in rural land designated for commercial development, and a change in education, welfare and household registration rules to reduce distortions – to ‘stamp out the phenomenon of families spending tens of thousands of dollars on unlivable pigeon-coop-sized houses near elite schools’.”

Still, there are scholars who believe that China’s priority should not be better efficiency in economic growth or raising the living standard, but growth itself. Scott Sumner of Bentley University argues that even if it does not produce “everything in the right order”, China ought to “produce lots more of almost everything”. These more optimistic scholars argue that China should produce as much as it can, until its capital per capita ratio and GDP level reach those of the U.S. and Japan. Xi Jinping’s announcement of a huge new economic zone in Xiongan, with the infrastructure build-out intended to cover 2000sq km (a size similar to the city of Shenzhen with 12 million people), indicates that his economic conviction belongs to the same boat. While he is president, China will have to deal with being called a miser and a wanton.

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